The long-awaited guideline on debt-for-equity swaps will help shed light on how the scheme unfolds, but analysts are concerned it could make implementation more difficult and lead to risks. First proposed by Premier Li Keqiang in March this year, the debt-for-equity scheme is viewed as a priority for Chinese leaders to reduce soaring leverage in the corporate sector, which hit 169 per cent of gross domestic product in the first quarter. Under the new guideline, released by the State Council last week, banks are not allowed to directly swap non-performing loans. Instead, they need to transfer them to qualified implementing agencies, including asset management companies and state investment firms, which will then convert the loans into equity. The conversion price is to be determined by the market and negotiated by banks, investors, debtors and the implementing agencies. “That makes swap negotiations even more complicated,” said Ivan Chung, the head of greater China credit research at Moody’s Investors Service in Hong Kong. For one swap to close, two kinds of negotiations have to be completed. That brings more uncertainty to the whole process The concern is echoed by Liao Qing, a senior director at financial institutions ratings at Standard & Poor’s in Beijing. “Under the new framework, for one swap to close, two kinds of negotiations have to be completed – the negotiations between banks and the implementing agencies about the purchase of debt holdings and then those between the agencies and the bond issuers about how to swap debts with equities. That brings more uncertainty to the whole process,” said Liao. “How the implementing agencies raise capital to buy the debt holdings from banks is also in question.” The guideline reiterated that fundraising had to be carried out under market principles, which is different from 1999, when China conducted debt-for-equity swaps involving 400 billion yuan with financial support from the Ministry of Finance. Besides the more complicated negotiation process,the scheme might be compromised by implicit government influence and a lack of transparency over the relationship among the parties involved, said Fitch Ratings. The ratings agency is concerned that banks could use their related parties as the implementing agencies. As the new rule allowed the scheme to be funded with social capital, which is likely to include mutual funds and wealth management products, banks might retain their exposure to corporates through complicated ownership and transaction structures, and transparency would be compromised, Fitch warned in its latest report. Moreover, the authorities have yet to outline plans to deal with the bigger problem of debt that resides with “zombie” companies. Although the government had said it would not assume responsibility for any losses involved or intervene in the transactions, banks were likely to feel pressured to support its policy objective of addressing over-indebtedness, raising doubts over whether “zombie” firms would really be kept out of the scheme, Fitch said. Even if these companies are kept out, the scheme will only deal with excessive leverage in certain parts of the economy and banks will remain exposed to other troubled businesses, which still make up the bulk of the corporate debt market and arguably pose the biggest risks to their asset quality.